Payroll Management: Understanding Standard Deductions

The least popular column on any pay stub always will be the one marked "deductions." For employees, this section has the effect of telling them: "Yes, you actually worked for that long and earned that much money, but here is how much is being taken out without your ever actually seeing it." It can be a little bit disheartening, to say the least. However, there are only two things in life that are certain, after all: death and taxes. We will deal with the latter here, and explain what needs to be deducted from the average gross salary to make it a net salary.

There are certain standard deductions and these are contributions to certain federal and state funds that are mandatory for anyone earning a living. The first and most prevalent of these is federal income tax. The federal government has a fund out of which it pays its own employees and from which it also finds the money to pay for government programs and general contingencies, among other things. This is funded from federal taxes, of which the main one is income tax. The rate at which this tax is paid will depend upon the earnings of the individual paying it. There is also a certain amount of the individual's yearly salary that is untaxed. All of these factors will be specified for each employee, and the amounts paid will vary among employees.

Another deduction from the average paycheck is labeled FICA, which stands for Federal Insurance Contributions Act. This is a fund that is fueled by payroll deductions in order to pay for Social Security programs and Medicare, which pays for U.S. citizens 65 and older to have medical treatment. At the time of writing, 6.2 percent of a monthly salary went to the Social Security fund, while 1.45 percent was earmarked for Medicare, and there was a cap on earnings eligible for Social Security contributions of $102,000, meaning that the more someone earned, the less he or she paid.

Other deductions may include state income taxes; not all states have these, but most do. These taxes go into a state fund that concerns itself with such things as road repair, communal facilities, and social programs for the disadvantaged. Further local tax deductions may be made depending on where you live and work. Because of urban overcrowding, it is not uncommon for civic authorities to pay a credit to residents if they live in the suburbs and work in the city, thereby encouraging people to move from the city.

All of the above fall under the banner of mandatory deductions. That is to say, if you earn a salary, these will be automatically taken from your paycheck at the point of issue. There are other kinds of deductions, and these are the ones that vary from paycheck to paycheck, from employee to employee. These deductions tend to go to programs chosen by the employee or sometimes the employer. One such deduction is for retirement plans. As the name suggests, these are deductions that go into an earmarked fund held for the employee as a kind of savings program.

The best-known retirement plan is the 401(k). This is a plan used by profit-making organizations, in which money is paid by the employee from his or her salary and is matched annually by the employer. Among the reasons for selecting a 401(k) plan is the fact that this money is not taxable. The deduction itself is made by the employer, and the 401(k) is held by the employer within the payroll department, which passes it on to the employee's next place of work should she or he change jobs. The 401(k) is mirrored in the public sector by a plan known as the 403(b-7). There are alternative plans, which vary between employers. The idea behind a retirement plan is that it will provide the employee a fund from which to draw an income in his or her retirement.

Voluntary deductions from a paycheck are usually called "benefits," and they constitute what is often referred to as a "benefits package." Besides retirement options, benefits include things such as health and life insurance. It is always advised for an employee to sign up for these plans, regardless of their non-mandatory status, as they represent an extremely good deal on insurance that would otherwise represent an expensive outgoing cost. Many employees who find that they have problems getting life insurance by themselves can profit from a company plan, as these are not subject to underwriting guidelines.

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Knowing about the different kinds of deductions is vitally important for anyone looking to work in a payroll department. It is essential that you familiarize yourself with an employer's financial package if you are going to work in their payroll department because, while the mandatory deductions will vary little between companies, the benefits packages can differ a great deal from place to place. Often a company will have a benefits coordinator specifically for these reasons.

Other deductions that can be found on a pay stub include provisions for disability payments, long-term care, personal savings, college planning, and flexible spending accounts.

For any employee, payday is like a Christmas holiday that occurs 12 to 52 times in a year. It is a day that is awaited enthusiastically, enjoyed when it arrives, and then the next month is spent counting the cost. The period of waiting for payday even has its own Christmas Eve: pay stub day, when the payroll department issues the paper slips telling the employee how much money they will receive. This heightens anticipation and makes the period leading up to payday seem a bit more bearable. You could even think of a pay stub as payday's very own form of Christmas card.

Of course, this is a flippant way of looking at it, and you certainly should not consider putting your monthly pay stubs on the mantelpiece next to your family portrait. Pay stubs are a major part of the record-keeping process for any company with a payroll, and they should also be part of any employee's records. They need to show the amount of work performed, the amount earned, the tax paid on those earnings, and a wealth of other information that may end up being indispensable when it comes time to file a tax return or to make a decision regarding the employee's financial situation.

Many people will, on getting their pay stub, look at only one box: the net wages. That is the final amount that will go into the person's bank account, and for many, that is all that matters. The phrase "bottom line" comes from this fact. When it comes right down to it, people are concerned with the here and now, and how it was reached is less of a concern. However, for official records and as a confirmation of financial information, a pay stub carries much more information and has more to offer the employee than just that bottom line.

Unless people calculate their own tax returns, the one and only time they look at a pay stub will often be on the day of its issue. But the stub carries more importance than just telling them what they are going to get. As well as the important transaction and calculation of their final net pay for the month, a pay stub details all of the information that went into deciding that amount and is an official document stating exactly how the payment was calculated. Therefore, if there happen to be any errors in the calculation or in the framework within which the calculation took place, they will show up on the pay stub.

The information that goes on a pay stub starts with the most basic of all: How many hours did the employee work? To figure out how much someone earns, this figure is taken and multiplied by the employee's hourly rate. Thus, if in a given month you work 140 hours, then your basic salary before deductions or additions will be 140 times your hourly rate. Then there is the question of overtime. Overtime usually counts for a higher pay rate than the basic hourly one, although this may not always be the case. Typical rates of overtime pay include time-and-a-half, when employees get an hourly rate plus half as much again; double time, when they receive double their hourly rate; and so on. So if an employee has worked, for example, 20 hours of overtime at double-time rates, he or she gets paid 40 times the usual hourly rate. Added to the 140 hours of normal work, this adds up to 180 times the hourly rate. This will appear on the pay stub, often with the title "gross pay."

The next overall heading on a pay stub is the deductions. The most obvious deduction will be money paid in taxes. How this amount is arrived at is dependent on the rate of tax that an employee pays and how much of her or his income is taxable. Purely as an example, if an employee's gross pay in a month is $1,000, subject to a tax rate of 25 percent, then theoretically the employee would pay $250 in taxes. But if, for example, only the first $800 of that thousand was taxable, then the amount paid in tax would come down to $200. As these amounts are simply examples, the calculations involved in working out what tax gets paid will differ widely when it comes to a genuine pay stub. There also are cases in which payments under a certain amount incur no tax, with the deductions only kicking in above a certain amount. Therefore, calculating tax deductions from an employee's pay is a difficult, often confusing, process the first few times you do it.

As well as rates and thresholds, different taxes also can muddy the waters when it comes to calculating what tax an individual pays. Depending on your state and even municipality, you may find that there are a few different taxes to calculate, all with different thresholds, rates and exemptions. Each of these must individually be included on a pay stub, with the amount that the employee has paid for each.

Pay stubs also will include the voluntary deductions that an employee has approved, such as for health insurance and company savings plans. All of these will be listed on the stub under their commercial names and possibly a brief description of the service that the money has gone toward.

As well as all this information regarding the month or week for which the pay stub is issued, a stub usually will contain cumulative amounts showing how much has been earned and deducted for the year to date. This is important information for people who have entitlements to a particular tax threshold or any benefits contingent on yearly earnings.

Once all of the calculations are done and all of the information is printed on the pay stub, it should be sent out to the employee to whom it pertains. Generally this is sent by mail to the employee's home address, but this is not a hard and fast rule. Some companies are known to e-mail pay stubs to their employees or to distribute them via the internal mail system. Different companies have different approaches but will make them perfectly clear before you start working for them.